Dollar Strength to be Short-lived: MUFG
- Written by: Gary Howes
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The U.S. dollar’s recent rebound is being driven by the global energy price shock triggered by the Middle East conflict, but analysts say the rally may prove temporary.
MUFG, the global investment bank and lender headquartered in Tokyo, says the current environment is not similar to 2022 when the dollar powered higher and registered outsized gains.
Here are the key insights from today's note.
Why the Dollar is Weaker:
"The energy price shock is spilling over into the foreign exchange market. The USD is benefitting from higher energy prices, similar to the last major negative price shock in 2022 following Russia’s invasion of Ukraine.
"USD strength is being reinforced by global terms of trade shocks, scaled‑back Fed rate cut expectations, and a squeeze in crowded short‑USD and FX carry positions," says a note released Wednesday by MUFG Bank.
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"The sharp deterioration in Europe’s terms of trade relative to the US was a key factor behind EUR/USD briefly falling below parity in 2022.
"Higher energy prices are prompting US rate market participants to scale back expectations for further Fed rate cuts this year which is an assumption that had previously underpinned forecasts for USD weakness prior to Operation “Epic Fury.”
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But, the Impact Should be Short-lived:
"We do not expect the Fed to deliver aggressive rate hikes as it did in 2022, when rapid tightening helped fuel outsized gains in the USD.
"Our latest forecasts are based on the assumption that Operation “Epic Fury” lasts weeks rather than months.
"If this proves correct, USD strength is likely to peak in the near term before reversing from Q2 onwards.
"We expect the USD rebound to prove short-lived as the energy price shocks begins to fade, and heightened US policy uncertainty remains a headwind."
"The negative energy supply shock from the Middle East is likely to prove temporary, with supply expected to return once the conflict fades.
"Market participants are increasingly concerned about the risk of a prolonged closure of the Strait of Hormuz, a critical artery for the global economy.
